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Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles


  • Ravi Bansal,

  • Amir Yaron

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    • Bansal is from the Fuqua School of Business, Duke University. Yaron is from The Wharton School, University of Pennsylvania. We thank Tim Bollerslev, Michael Brandt, John Campbell, John Cochrane, Bob Hall, John Heaton, Tom Sargent, George Tauchen, the Editor, an anonymous referee, and seminar participants at Berkeley (Haas), CIRANO in Montreal, Duke University, Indiana University, Minnesota (Carlson), NBER Summer Institute, NYU, Princeton, SED, Stanford, Stanford (GSB), Tel-Aviv University, UBC (Commerce), University of Chicago, UCLA, and Wharton for helpful comments. We particularly thank Andy Abel and Lars Hansen for encouragement and detailed comments. All errors are our own. This work has benefited from the financial support of the NSF, CIBER at Fuqua, and the Rodney White Center at Wharton.


We model consumption and dividend growth rates as containing (1) a small long-run predictable component, and (2) fluctuating economic uncertainty (consumption volatility). These dynamics, for which we provide empirical support, in conjunction with Epstein and Zin's (1989) preferences, can explain key asset markets phenomena. In our economy, financial markets dislike economic uncertainty and better long-run growth prospects raise equity prices. The model can justify the equity premium, the risk-free rate, and the volatility of the market return, risk-free rate, and the price–dividend ratio. As in the data, dividend yields predict returns and the volatility of returns is time-varying.